Middle East economy: Key issues for 2011

FROM THE ECONOMIST INTELLIGENCE UNIT

The Middle East and North Africa (MENA) region will record economic growth of 4.3% in 2011, a modest increase on estimated growth of 4.1% in 2010, according to the Economist Intelligence Unit. The rate of growth will be slightly stronger in the oil-exporting countries, as we expect oil prices and production to be higher next year in response to robust demand growth in Asia in particular. The sub-region of the six Gulf Co-operation Council (GCC) member states will witness real GDP growth of almost 5%, but this will stem largely from the forecast growth of 15.9% in Qatar.

The MENA region was relatively lightly affected by the global recession, and consequently there has not been any major change in the general direction of economic policy. The most notable exception was the emirate of Dubai, which diced with default at the end of 2009 and has been forced to adjust its economic strategy to deal with the formidable challenge of restructuring the debts of its government-related entities. That has required retrenchment and an acceptance of the need for asset sales—a recent example (and a profitable one) was the divestment by DP World of 75% of its holdings in a number of Australian ports. Elsewhere in the GCC, governments will continue with long-standing policies of economic diversification, focusing on the development of services and non-oil industries and seeking to equip their own nationals to play a much more prominent role in the labour force. Outside the Gulf most MENA governments are aspiring to achieve growth rates of 5% and higher through attracting increased levels of foreign direct investment, developing export-oriented industries and streamlining regulations so as to encourage private businesses.

Oil outlook

The oil and gas sector will remain a critical determinant of economic performance in the MENA region. The oil price has risen over US$90/barrel in December 2010, and we expect it to remain strong in the first two quarters of next year. The price has been driven up by a recovery in demand and by the lingering perception in the market of potential tightness in supply in the medium term. We expect the price to moderate in the second half of the year as demand eases, supply from OPEC edges up and the US dollar strengthens.

Oil to spare

OPEC currently has effective spare capacity of just over 5m barrels/day, according to the International Energy Agency (IEA). This is likely to taper down to 3.6m b/d by 2015, based on the IEA’s projections for demand for OPEC crude and for additions to capacity. The IEA has a conservative outlook for the latter, and expects OPEC capacity to rise by only 2.1m b/d by 2015, including an extra 1.1m b/d in Iraq and most of the remainder coming from the UAE, Angola, Saudi Arabia and Libya; Iran’s production capacity, meanwhile, will slip from 3.9m b/d to just 3.1m b/d in 2015, according to the IEA. (We are slightly more optimistic than the IEA with respect to Iraq, which we envisage producing 4.2m b/d in 2015, compared with 2.5m b/d now.) Based on the IEA’s assumptions, the oil market is likely to be adequately supplied over the next five years, but the shrinkage of spare capacity suggests that there will continue to be upward pressure on prices from fears of a supply crunch—these concerns would be mitigated if oilfield projects in Iraq and Brazil were to advance more quickly than generally thought. We expect the oil price to trade in a range of US$70-90/b in 2011-15.

The gas paradox

Natural gas also plays a central role in many MENA economies. The development of shale gas in the US has changed the dynamics of the global gas industry, and has had a particularly marked impact on the outlook for liquefied natural gas (LNG). It had previously been assumed that the US would account for a large part of the anticipated surge of demand for LNG. However, the advent of new unconventional domestic gas supplies has meant that the US is now exporting cargoes of LNG—with buyers said to include Gulf Arab states.

Qatar has meanwhile completed its LNG expansion programme, and has the notional capacity to export 77m tonnes per year, making it by far the largest supplier in the world (marketing issues and the need for shutdowns for maintenance mean that actual production is likely to be about 10% below this figure). The legacy of the LNG programme means that the Qatari economy will once more show double-digit growth in 2011, but thereafter will slow to about 6% as the moratorium on new gasfield development is maintained. Qatar’s dominant position in the LNG market will insulate it to a large extent from the effects of lower natural gas prices in the US, and it is likely to focus its sales efforts on Asia. Its success in winning the contest to host the World Cup in 2022 will result in increased investment in infrastructure, which will ensure that Qatar is likely to continue to be the fastest-growing economy in the GCC, albeit by a smaller margin than in recent times.

Arab states run short of gas, while Israel taps new riches

Most of Qatar’s GCC neighbours are facing constraints on the supply of gas, which is vital for electricity generation, desalination and energy-intensive industries such as aluminium (one of the major growth industries in the GCC). Qatar sells natural gas to the UAE via the Dolphin pipeline, but at a price well below even the current world market average. Dubai is now buying some LNG from Qatar (at market prices) and Kuwait has also become a buyer on the global LNG market. Saudi Arabia is not producing enough gas to meet all of its domestic needs, which has obliged it to burn increasing volumes of oil in its power stations. Saudi Aramco is investing heavily in new gasfield developments to address this issue. Iraq faces a more acute challenge, as it will find that it is using much of its new oil production to run its power stations (rather than generating export revenue) if it fails to make better use of its abundant natural gas resources. Gas is also a critical issue for Algeria and Egypt, which have both been obliged to rein in gas export plans owing to rising domestic demand and lags in developing new production capacity. Egypt is now seriously considering the option of supplementing its domestic gas supply with imports. One of the current customers for exported Egyptian gas is Israel. This relationship may ultimately be reversed as Israel brings on stream potentially prolific offshore gasfields that are now being developed—although work is being held up by a dispute over the size of the government’s take.

Biting the subsidies bullet in Iran

The recent rise in oil prices and the pressures on domestic fuel supplies have forced many MENA governments to tackle the thorny issue of energy subsidies. Jordan, Syria and Egypt have made some progress towards limiting the fiscal drain of energy subsidies over the past two-three years—although in Egypt this is very much a job half done, as some of its measures were put on hold with the onset of the global recession. Iran is now embarking on a major assault on subsidies, with the attendant risks of stoking up hyperinflation and provoking violent popular protests. The government is trying to soften the blow by providing monthly cash compensation of US$40 per person, but the scale of the price increases is daunting, with the price of the petrol ration going up fourfold to 40 US cents per litre, and diesel prices increasing almost ten times to 15 US cents per litre (however, it is by no means clear how widely available was the previous price of just 1.65 US cents per litre—which would have made the cost of filling a truck’s tank about US$1). An added impulse for Iran is the need to deal with the effects of sanctions on its ability to import fuel. The government has no doubt calculated that cutting subsidies will drive down consumption, particularly as it will eat into the fat margins of fuel smugglers.

Markets to watch

The MENA countries offering the most promising prospects for business include Saudi Arabia, Egypt, Abu Dhabi, Qatar and Iraq. Others with potential include Syria, Kuwait and Libya. The Saudi economy grew by 3.8% in 2010, according to a government estimate in late December. This performance was stronger than our expectations, but rested to a large extent on growth in public investments. The Saudi private sector remains relatively subdued, partly owing to the cautious stance of the kingdom’s banks, which were badly burned by the Saad/Algosaibi debt defaults in 2009 (this saga is still rumbling on). However, financing of major projects in Saudi Arabia faces little difficulty. The state usually has significant input in such projects through equity stakes, offtake guarantees or loans from government agencies, and Saudi Arabia (in common with most MENA states) is benefiting from the general surge in investor interest in emerging markets.

The Egyptian government will remain focused on attracting FDI to help it to meet its ambitious medium-term growth targets (rising towards 9%), but some investors may be deterred owing to concerns about political stability as the presidential election looms.

Abu Dhabi and Qatar are both forging ahead with imaginative development plans, underpinned by enormous oil and gas wealth. However, Abu Dhabi still has to reckon with the impact of the Dubai crash, and the government is also having to pump considerable funds into some of its own corporations, which have incurred losses from real estate projects. The main worries with respect to Qatar are the weakness of the global gas market and the risk that its North Field reservoir may have incurred damage owing to the intensive exploitation of the field over the past two decades.

Syria and Libya are gradually embarking on the path of reform, which is starting to attract interest from serious investors. However, in neither case has the argument in favour of fully opening up the economy to private business been conclusively resolved. There is a similar risk of backsliding in Kuwait, although on paper its 2010-14 development plan offers a host of opportunities.

Finally, we expect Iraq to be the fastest-growing economy in the MENA region next year (apart from Qatar), with real GDP expanding by 6.5%. However, this is still below potential and will largely be accounted for by increased oil output. The Economist held its first business conference on Iraq in 2010, which reflected the growing perception among MENA-focused businesses that it is a market to take seriously, but which is still beset with debilitating regulatory problems and whose security and stability are far from being assured.